All That Glitters / Beware the Optimists

In the exact sciences, at any given point in time there is a model that represents the accepted theory, meaning, it describes the widest consensus among the people in that field. In cosmology, the science of the universe and its creation, they call it the "standard model." It states that the universe began with a big bang and is constantly spreading. Ultimately, the standard model of cosmology predicts that the universe will spread to the point of infinite dilution. Nothing will remain. All gone.

Models, naturally, evolve. They develop as new information comes in, which may weaken or strengthen the model. Also, they are almost always controversial.

Economics is not an exact science, but it has its standard models. Before this last global economic crisis, the standard model ruled that markets are a balancing factor that self-correct, that financial systems can overcome any internal imbalance, and that stability of that financial system will promise a protracted period of steady growth, without crises.

The crisis upset the theorists' applecart. Many threw out their fundamental assumptions, such as the market's advanced nature. But as the dust settles and recovery takes shape, again "standard models" are being consolidated regarding economics in the years to come. Naturally, forecasts are also starting to pop up, and as the Economist put it: After the storm, a "new normal" is taking form.

It is only human to crave "normalcy" after meltdown. People want predictability. It is therefore unsurprising to find the phrase "new normal" in official communiques from the leaders of the G20 big industrialized nations last month.

What does this "new normal" look like? Here you go: The global economy will grow by a moderate 3% a year. Unemployment will remain high in the West and public consumption will turn into the main driver of growth. Private consumption will remain far below the levels we'd been accustomed to before the crisis. Problems arising from the past, such as the American consumer's groaning debt, will continue to take a toll.

After the crisis period's low points, the world will see a few quarters of brisk growth. But economic activity won't return to what it used to be.

Alan Greenspan, the former chairman of the U.S. Federal Reserve Board and the man who led the global economy for 20 years, said last week that much of the recovery is because of the steep increase in stocks and bonds. But after 50% gains this year, don't expect 50% next year, he warned.

Greenspan's forecast for the next year is 10% unemployment and lukewarm growth.

He isn't the only one not predicting fireworks. Investment guru George Soros thinks the American financial system is still in a state of de facto bankruptcy. Therefore, Soros concludes, the American economic recovery will be a sluggish thing.

"Bonds King" Bill Gross, manager of Pimco, which has $900 billion in managed assets, was one of the first to use the phase "new normal." He thinks the expected slow growth will depress returns on stocks to 5% a year.

Meanwhile, the world leaders at the International Monetary Fund conference in Istanbul last week behaved as though everything had returned to normal. They had nothing special to say in their press releases. They didn't even bring up the feeble dollar, an issue that actually has economic leaders sweating bullets.

As in any science, the "standard model" is just an interpretation that happens to command a consensus at a given point in time. There can be other models, some more optimistic, some more pessimistic.

Watch out for the optimists in the marketplace, dear reader. Most make their living from trading in stocks, in one way or another, and when stocks are rising, so are their personal fortunes.

But don't bend toward the pessimists, either. Some of them make their living from short-selling securities, and bear markets work in their favor. Others simply know that wailing like a latter-day Job is a good way to get the press' attention.

That said, the pessimists make a good case. The credit market remains frozen. Experience teaches that exiting a recession takes years, and share prices are already above their multiyear average.

Over time, the consensus is almost always wrong, then another model comes along. Or, as "The Black Swan" economist-philosopher Nassim Taleb told TheMarkerWeek: So what if everybody's optimistic. They were even more optimistic before the crisis erupted, and look where it got us all.

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